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i understood the terminologies with an example of shares
benefiting on long position on shares here someone will buy shares lets say for 100 and expect them to rise to 120, if they rise to 120 he sells them at 120 and he will profit by 20
benefiting on short position, here someone will borrow shares and sell shares lets say for 120 and expect them to depreciate, so if after some time the shares fall to 80 he will buy these shares back and return them from where he borrowed them and hence profiting 20
I am confused when i want to apply this on futures, please help me with an example
Futures work in a different way (there is no borrowing of them involved), and I explain both foreign currency futures and interest rate futures in detail (with examples) in my free lectures on foreign exchange risk management and on interest rate risk management.
Thats exactly where i am confused because in your lectures you said there is no borrowing, so how does it work in futures
example
You enter into a futures contract to sell 100 shares of IBM at $50 a share on April 1 for a total price of $5,000. But then the value of IBM stock drops to $48 a share on March 1. The strategy with going short is to buy the contract back before having to deliver the stock. If you buy the contract back on March 1, then you pay $4,800 for a contract that’s worth $5,000. By predicting that the stock price would go down, you’ve made $200.
i am confused on where the 200 profit actually comes from because there is no borowing on futures and if a person buys it back he stays with it, how does he profit, Please i need your help
Both financial futures and interest rate futures are effectively just gambling.
You tell the dealer that you want to ‘sell’ futures, but you are not actually selling anything. However you have to later ‘buy’ the futures. However, again you are not actually buying anything. At the end of the deal the dealer simply subtracts the price when you ‘buy’ from the price when you ‘sold’ and if a profit then the dealer pays you. If a loss, you pay the dealer. It works the same way if you ‘buy’ first and ‘sell’ later.
Because the markets for futures are very large, there are always people buying futures and always people selling futures. The dealer adjust the price each day to keep both buy and sell markets going, and in that way makes sure that the profits that he/she is making cancel out the losses they are making.
I know it might sound strange that it is pure gambling and that you are not actually buying and selling anything, but that is what is happening. In the same way, the financial exchanges allow you gamble on the movement in the index of house prices – you can gamble on average house prices increasing or decreasing. The financial exchanges allow you to gamble on the results of general elections in the UK. In both of these cases you are not buying or selling anything – they use the words ‘buy’ and ‘sell’ simply to describe which way the gamble is going (i.e. whether gambling on the price increasing or gambling on the price decreasing).
With both financial futures and interest rate futures, there are many people who do it purely as a gamble. As I explain in the lecture, if you think the value of a currency is going to increase then you could simply buy lots of the actual currency and sell it later. However to make a decent profit you would need a lot of money to buy the currency in the first place. With futures, you do not need to pay out all the money (although you do have to pay a returnable deposit) and so can gamble a lot more.
However, as I again I explain in the lecture, financial managers should not use the companys money purely to gamble with – the financial managers uses the gamble to hedge against the risk that attaches to an actual separate real transaction.
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